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Can companies rely on single high growth segment? - Views on News from Equitymaster
 
 
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  • Sep 16, 2011

    Can companies rely on single high growth segment?

    For companies to flourish in the long term, they need to be in businesses which are sustainable. Over dependence of revenues on one segment alone can be injurious to the health of the company and detrimental to shareholder wealth. Especially, if growth in that segment slows down for any reason.

    Several Indian companies, especially ones in the mid and smallcap space are one product wonders. While there is no wrong is focusing one's core product or service, diversification in related spaces is a necessity we believe.

    A blue-chip company that has several product in its portfolio but relies very heavily on one is equally vulnerable. Take the case of Titan Industries. We all know that Titan is the most talked about investment story of the last decade. This is because the company's share price has grown multifold. The growth in net profits has also been impressive (5 year CAGR of 42%). The watches company got into the business of jewellery making and this drastically altered its revenue mix. Current over dependence on jewellery segment is evident from the fact that jewelley accounts for 75% of overall revenues. The jewellery business grew by almost 44% in FY 11 as compared to the previous year.

    But, will this growth continue for long term? Probably not and the management seems to have realized that. The main reasons for the growing demand of jewellery are that customers' tastes and preferences are changing and so are their lifestyles. Thus, they prefer to shop for jewellery in the comfort of a branded showroom with more options on offer under the same roof. The fact that gold jewellery is also looked upon as an investment option in India has added to its glitter. This was more prominent during times when the stock markets were volatile and consumers considered gold and gold jewellery as a safe haven. However, the company cannot over rely on the jewellery business in the longer run. Titan's management has been known for its foresightedness and it has already started looking for other avenues of growth. The company is mulling getting into new categories of consumer retailing like fragrances, footwear, etc.

    We believe that this is a step in the right direction. However, the company should not go overboard with its diversification strategy. As for the other companies, they should take cues from such diversification strategies and ensure that their own growth prospects are sustainable in the longer run. It would make sense to keep exploring other opportunities if the reliance on a particular segment is becoming too risky. The investors need to keep the sustainability of revenue growth and profitability in mind when selecting stocks for the long term.

     

     

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